JPMorgan’s capped contingent buffered notes tied to gold offer moderately bullish play

By Emma Trincal

New York, Jan. 18 – JPMorgan Chase Financial Co. LLC’s 0% capped contingent buffered notes due July 24, 2020 linked to gold should appeal to investors with a moderate bullish bias on the precious metal, said a contrarian portfolio manager whose view is more upbeat.

If the final price of gold is greater than its initial price, the payout at maturity will be par plus the percentage increase in the price of gold, subject to a maximum return of 20.55%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final gold price is less than the initial gold price by up to 10%, the payout will be par. If gold declines by more than 10%, investors will lose 1% for every 1% that the final gold price is less than the initial gold price.

Steven Jon Kaplan, founder and portfolio manager of TrueContrarian Investments, first assessed the barrier level.

90% barrier

At first glance, the protection appeared weak, he said.

An 18-month unleveraged capped note with a 90% barrier linked to the S&P 500 index would seem unimpressive in comparison.

But gold was different.

“Unlike what most people think, gold is not as speculative as the stock market. A 10% drawdown doesn’t happen that often,” he said.

This is not to say gold can’t be volatile at times, he noted.

For instance, between 2001 and 2011, the precious metal appreciated seven-fold.

“It also dropped significantly in December 2015 almost at the same time as the Fed raised rates for the first time after years of easing,” he said.

“Since then it has been going up but slowly.”

Different cycles

Another important difference between stocks and gold, which justified in his view the 90% barrier, was the way prices fluctuate in time and intensity when comparing the two asset classes.

“The stock market has a consistent pattern that’s aligned with the economic cycle. Typically, you can have a bull market that will last between four and 10 years followed by a much shorter bear, of let’s say one, one and-a-half year and that’s when you can see the market drop 50%.

“It takes time for the economy to improve. Companies start to see more profit, they hire more people. It’s a slow improvement cycle, which is why bull markets last longer. Once the economy begins to slow, you start to see layoffs happening quickly. It’s a more brutal process but it takes place over a shorter timeframe,” he said.

Even the worst bear market during the Great Depression lasted less than three years, between September 1929 and July 1932, he noted. Then followed the strongest bull market in history from July 1932 to March 1937.

“It was very similar to our current bull market only it was shorter and stronger,” he said.

A bet for this year

Gold market cycles in comparison are less predictable.

“You don’t want to miss it or time it wrong,” he said.

The current bear market in gold is about to end, according to this portfolio manager. But the window of opportunity for bulls may be tight.

“I think we’ll surpass the 22% cap easily this year but not necessarily in 2020,” he said.

“I’m very bullish but not for a long time, not beyond 2019. The notes are fine if you think prices are going to rise slowly and moderately. Then you don’t mind the cap.”

At least the notes provided some downside protection, which he said is always useful to have.

But the timing was still a concern with a maturity date only four months ahead of the presidential elections.

“The elections next year are going to bring a lot of uncertainty, a lot of volatility,” he said.

Investors buying structured products need to have a “directional” view of the market. They also need to have a time horizon in mind since notes akin to options contracts have a limited life.

The bullish case

Kaplan’s bullish opinion on gold was the result of a positive outlook on global equity in relation to U.S. markets as his prediction is that the dollar will weaken further.

“The reason the dollar was so high in 2018 is because most world markets were down, and not just emerging markets but developed countries as well, especially in Europe,” he said.

Some countries such as China and India saw their stock markets collapse, showing declines of 50%.

“People don’t realize the extent of the bear market in other parts of the world because the opposite happened in the U.S., at least for most of the year,” he said.

“Everybody was very excited about the Trump policies, the tax cuts. As a result, the dollar rallied strongly.”

Golden savings

There are consequences when the so-called “wealth effect” negatively affects other countries in the world.

“The dollar being so high, demand for commodities has dropped,” he said.

But some cultural and social trends have also contributed to push gold prices down.

“In countries like China, India, Malaysia or Indonesia, gold is a common form of savings. Instead of putting some of your salary in a 401K, you buy a little gold here and there, for yourself... as a gift. It is how people save for the future.”

When some of these large emerging market countries suffer steep losses in the stock market, the wealth effect” plays out negatively. Investors in those regions can no longer afford to save and therefore, demand for gold drops.

“We don’t measure the impact of the Indian or Chinese gold markets on the price of the precious metal. But it’s huge,” he said.

Kaplan projects a recovery in international stocks. But he believes that the U.S. is at the beginning of a bear market.

“As the dollar keeps on dropping in 2019, the rest of the world will be in recovery mode from the severe losses of 2018. The weaker dollar will support demand for gold and for commodities in general.”

Keep it short

This year should offer a good opportunity for gold and emerging markets, he said.

He is not so sure the same thesis will apply next year as he expects a recession.

If his scenario is correct, a recession in the United States would make the dollar attractive again as a safer instrument, which would put an end to the gold rally.

For now, though the best macroeconomic conditions are in place to support gold for the next 12 months.

“You don’t want to have a recession when you buy gold. What you want is a combination of growth and rising inflation. I think 2019 is going to bring us the perfect formula for this.”

In conclusion, Kaplan said he wouldn’t buy the notes with an 18-month tenor.

“I’d rather have a one-year or be long gold. Once you get to 2020, you start to run the risk of having a worldwide recession. It’s been 10 years since we have had one. It’s overdue.”

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes are expected to settle on Jan. 24.

The Cusip number is 48130UPY5.

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